HL Select UK Income Q4 2020 Review

Steve Clayton - Fund Manager

22 January 2021

UK Market Review

The final three months of 2020 saw stock markets globally focusing on the prospects for economic recovery and stimulus efforts by authorities in the leading nations of the world. News of effective vaccines further propelled the markets higher, leading to a quarterly total return for the UK stock market of 12.6%.

With vaccinations comes the prospect of a return to something far closer to what used to be regarded as normality. Even if there is another period of lockdown to be endured before the hoped-for herd immunity is reached. This change in outlook prompted significant rotations in market leadership. Areas where the pandemic had hit hardest enjoyed a degree of recovery, whilst perceived “safe havens” fell out of favour.

At the very end of the quarter, a Brexit deal was announced, allowing the worst-case scenario of a no-deal outcome to be banished, giving a further boost to investor sentiment. The outcome of the US Presidential elections saw Joe Biden win office, but perhaps not much power, since control of the Senate rests on the Vice President’s casting vote, there being no underlying majority in place.

Hopes of an end to pandemic pushed energy and other commodity prices higher, even though travel remains tightly restricted in much of the world. Banking shares benefited from an easing of concerns over the scale of bad debt that will be left in the pandemic’s wake. For the quarter as a whole, the major market sectors were led by Banks and Oil Producers, which delivered total returns of 33.9% and 28.2% respectively. The major laggard was Pharmaceuticals, which lost 9.6%.

As we start the New Year, investors can bask in the comfort of a realistic prospect of vaccines bringing an end to the pandemic in Europe and North America. Brexit has gone relatively smoothly; central banks remain highly accommodative and President Trump is about to leave office. Markets go up when things are getting better. How much better can they get from here?

HL Select UK Income Shares Quarterly Performance

The fund delivered a positive return of 11.4%, compared to the wider market return of 12.6%. For the year as a whole, the fund delivered a return of -8.6% very slightly ahead of the market return of -9.8%. Past performance isn’t a guide to the future.

The chief driver of the performance in Q4 was that our life assurance stocks and our holdings in utilities and real estate lagged their wider sectors. On the positive side, we saw a strong return from GB Group which added 1.2% to the fund’s value during the quarter. We look at the major winners and losers in more detail below.

Past performance isn’t a guide to the future. Source: Lipper IM 31/12/2015 to 31/12/2020.

N/A = performance for this time period is not available.

Significant Winners and Losers in Q4 2020

Winners

Past performance is not a guide to the future. Source: Bloomberg (30/09/2020 – 31/12/2020)

With the market betting that a vaccine-driven recovery was now on the cards, banking shares gained ground, on the basis that a cap had now been placed over their bad debt charges and that improved confidence might spur better income growth. Close Brothers benefited strongly, as investors viewed its pure domestic nature would make it a direct beneficiary of a UK economic recovery. Lloyds too participated in the rally, adding almost 40% in value, not quite matching Close Brothers’ performance. Lloyds should be benefitting from the ongoing housing market recovery, and we have seen evidence of mortgage pricing firming up in recent months which should prove of benefit.

Next too falls firmly into the camp of businesses that should benefit from recovery. Clearly the current lockdown will be hurting, but as we have previously observed, despite their High Street presence, the company is predominantly an online retailer. The company pushed their underlying profit guidance higher in a statement in early January which has ensured a strong start for the stock in the New Year.

GB Group reached new all-time highs towards the end of the quarter. Interim results in December revealed continued strength across the key divisions and with banks increasingly likely to lift lending levels as bad debt risks recede, the outlook for organic growth at GB looks positive. Their adjusted earnings growth of 30.5%, during a pandemic is indeed impressive. As ever, the group’s position within the ecommerce supply chain leaves it well placed to grow over the longer term.

Legal & General was buoyed by recovery hopes and also its announcement of a new dividend and capital strategy that should see the group continuing to offer a strong dividend to investors, although please remember that dividends are variable and not guaranteed. The portfolio has proven resilient through the ups and downs of the pandemic and if the group execute their plans effectively, dividends should be well backed by cash generation in coming years.

Last quarter we wrote that Paypoint had announced an Ofgem enquiry on the last day of the quarter, leading to a sharp drop in the stock. During Q4 the market came to the view that the matter was not going to prove impactful and the stock recovered all of that earlier drop and more. The company also announced acquisitions that take it deeper into the Payments sector, offering improved growth potential.

Energy companies enjoyed strong rallies in the quarter, aided by a recovering oil price as economic optimism mounted. The fund’s holdings were no exception and made useful contributions to performance. We see the current oil price, in the low $ fifties as approaching a level where energy producers are likely to feel more confident in their cash generation potential, which could have positive implications for their dividend paying capacity, however we must not count chickens before they hatch!

The strong performance of Ascential is not a surprise. Their events business should be a major beneficiary of the re-opening of economies. Ascential owns two major events – Cannes Lions and Money 20/20 – both of which rely on international travel. In truth, we don’t know whether these events will go ahead as planned in 2021 but looking to 2022 and beyond, we can now be much more confident of these events returning. In the meantime, their digital businesses supporting the e-commerce sector can keep the group motoring along.

Losers

Past performance is not a guide to the future. Source: Bloomberg (30/09/2020 – 31/12/2020)

Our weaker performers this month were those businesses that have fared relatively well through the pandemic, and are seen as well insulated from covid headwinds. The vaccines are not going to meaningfully alter people’s propensity to buy Ben & Jerry’s ice cream, for example, so Unilever’s lacklustre performance isn’t a major surprise.

The same applies to Pennon and National Grid. The prospect of a few more people paying their water bills on time isn’t enough to get the pulses racing. They’ve all been very resilient performers for us through the pandemic and vaccine news saw a rotation towards more obvious beneficiaries.

Pharmaceuticals were the market’s weakest sector and both AstraZeneca (AZN) and GlaxoSmithKline (GSK) gave ground. With investors in a more adventurous mood, the defensive nature of drug makers was out of favour. GSK suffered a setback in the timings of its own Covid vaccine project, whist AZN was penalised for both some uncertainty around the dosing regime of its vaccine and also a hesitant reaction by the market to AZN’s proposed acquisition of Inflexion for $39bn. It should be remembered that AZN is supplying its Covid vaccine on a non-profit basis.

Sanne group lagged the wider market in the quarter. A trading statement in early December went someway to improving sentiment and the stock did claw back some of its earlier losses to end the quarter 6% down. The business is seeing growth held back to a degree by the slow pace of fund raisings by its clients. We expect that this issue will ease when the wider economy reopens, both at home and abroad. Investor’s needs for Sanne’s services are unlikely to have been much impacted, indeed the current ultra-low interest rate environment arguably increases demand for the alternative assets that Sanne administers.